Trust revolutions and the need for blockchain

In my previous post, I outlined what makes blockchain a transformative technology. It builds trust in data and business networks, which makes it the latest part of a long history of trust as the basis for economic transactions.

People trust each other based on personal knowledge. I trust you because I know you and what you have done.

That worked for small groups of people; tribes and ancient villages. If your roof leaks and the rains are coming, I will help you to fix it, because I trust that you will provide some reciprocal help at a future date. Sociologists say this type of favor-based personal trust breaks down once a community has more than about 150 people.

Therefore, throughout history, humanity had to invent new trust mechanisms to scale the economy.

The first real innovation in trust was coins, first minted around 640 BC in Lydia (modern Turkey). They are a universal mechanism of immediate asset exchange that enable someone to sell and olive crop, take the coins to the local market and buy clothes for their family. Coins have no inherent value, but each person trusts them because everyone else does and they are backed by a central trust authority, in the past a king or emperor, with power derived from the gods. As long as the king and his kingdom stood, the coin had value and citizens could trust it.

Coins enabled accumulation of wealth. There are only so many favors you can accumulate, but there is no limit to the number of coins you can have. This enabled villages to gather wealth and become cities, and it enabled cities to levy taxes to build temples, walls, roads and theaters.

Coins also enabled portability of wealth. A professional soldier in a field in England could take coins back to his family in Greece, for example.

This trust in coins, based on central trust authorities, underpinned the classical world, enabled trading networks such as that of the Phoenicians and helped to build the first great empires: Roman, Persian and Han. Human economic activity then stayed roughly the same for the next 2,000 years.

Around 1500 AD, the ‘new world’ was re-discovered by Europeans, creating a demand for exploration and investment. There was also a wave of religious reformation across Europe, which meant that it became acceptable to make money from money (this had been considered a sin).

To build a ship and sail it across the ocean was incredibly expensive and highly risky. Very few individuals could afford that, but groups of people could fund a share in a ship and take a share of the risk and profits, which was more acceptable. The concept of limited liability companies was born.

Insurers such as Lloyd’s of London offered to spread the risk on those ships and banks started to collect money from small investors, buy up the shares and pass on the returns in smaller (but more reliable) amounts.

The real innovation here was intangible money, money which you cannot see but which will come back to you in the future. You can hold a coin in your hand; you can’t hold a share. You can hold a piece of paper which says ‘share’, but you are ultimately trusting in the limited company, the insurers, the banks and the legislation which underpins that. Lawyers call these “legal fictions.” They don’t actually exist, yet we put our trust in them anyway.

This concept of a monetary system saw an explosion in the amount of capital available for exploration and trade. It underpinned the great commercial empires like the East India Company and the Hudson’s Bay Company, funded the Industrial Revolution and paved the way for Bretton Woods and the modern economic system we have today.

All of that is based on central trust authorities. But we’ve moved on from kings and gods as the basis for currency, in favor of corporations, banks and governments. That’s why we need blockchain, which I’ll discuss in my next post.